Central Bank cites easing inflation, weaker external demand as reasons for rate cut

The Central Bank (CB) said it eased monetary policy on Thursday (22) due to a lower-than-anticipated inflation path and weaker-than-expected aggregate demand, stemming from geopolitical uncertainties following the imposition of broad-based tariffs on the United States’ (US) trading partners.

The CB trimmed its Overnight Policy Rate (OPR), its key policy rate to signal the direction of monetary policy, by 25 basis points on Thursday, contrary to broader expectations that rates would be held unchanged.

As a result, the standing facility rates of the Central Bank—the Standing Lending Facility Rate and the Standing Deposit Facility Rate—were reduced by the same amount, to 8.25 percent and 7.25 percent respectively. The two standing facility rates are maintained at margins of plus or minus 50 basis points from the OPR.

Explaining the rationale behind the move, Central Bank Governor Dr. Nandalal Weerasinghe said the outlook had shifted on two fronts since the last monetary policy meeting in March, creating space for a rate cut at the most recent meeting.

“First, we saw the inflation projection for the next 12 to 18 months is moving in a lower path now than the one before at the March meeting. However, the inflation is still reaching towards our target of 5 percent,” Dr. Weerasinghe said.

“Second is, in terms of the aggregate demand, compared to the last (monetary policy) review, because of the global uncertainties, the IMF has also revised their global outlook. That means, from the overall aggregate demand point of view, the external demand component would certainly be lower than what we expected last time,” he added.

Many global central banks, with the exception of the US Federal Reserve, have lowered interest rates since the announcement of baseline tariffs and reciprocal tariffs on almost all US trading partners on April 2.

A week later, the US suspended the higher reciprocal tariffs for 90 days, leaving the 10 percent baseline tariff in place. This move helped ease trade tensions that had rattled global trade and financial markets.

Central banks including the European Central Bank, Bank of England, Bank of Canada, Reserve Bank of India, and Reserve Bank of Australia cut rates to soften the potential blow of the tariffs on their economies and aggregate demand.

The Central Bank of Sri Lanka’s move last week was largely in line with these actions. However, Dr. Weerasinghe noted that Thursday’s decision was also based on the expectation that the current status quo on tariffs impacting Sri Lanka would remain in place, and that the higher 44 percent reciprocal tariff would not be reimposed. Reinstating this higher tariff could prompt a reassessment of the Central Bank’s monetary policy due to the interconnectedness of trade and monetary policy.  “When it comes to Sri Lankan exports, we still don’t know the impact. We still have a 90-day pause. We have to see what the  outcome would be. This is without taking into consideration any changes and expecting the same status quo would remain beyond the 90 days, but already there are downward revisions to the external demand,” he said.

He added that the Central Bank would reassess its current monetary policy stance at the next review in two months to determine whether the outlook has changed again, potentially creating more space for policy action or necessitating adjustments.